Contents

CMBS

Making hay

Private-label multifamily origination moves aside for agency CMBS

US agency CMBS volume has risen at an average clip of 50% per year post-crisis, hitting a record US$107.9bn of issuance in 2017. A new Trepp study suggests that the sector’s growth has come at the expense of private-label multifamily origination.

The average annual agency CMBS issuance during 2010-2018 grew to US$64.9bn from a previous average of US$4.9bn for the 2000-2009 vintages, with multifamily borrowers appearing to prefer agency financing post-crisis over private-label, due to its competitiveness and certainty of execution. Joe McBride, director - research and applied data at Trepp, says that the sector benefits from a “double-whammy” positive effect: strong macro growth, due to ‘generation rent’, plus bondholders are protected and are paid a decent yield.

“Lenders are selling multifamily loans to the GSEs at lower yields than other property types in other deal types, which enables them to provide more economic financing for borrowers. At the same time, bond pricing is more favourable to borrowers because of high investor demand. It’s a favourable dynamic,” he continues.

The Trepp study identifies 3,100 loans (with a balance of US$40.8bn) that were originally securitised in a conduit CMBS and subsequently resecuritised into an agency deal between 2010 and 2018. Only 69 loans (US$950m) were identified as having switched from agency financing to private-label during this period.

In terms of collateral for conduit deals that have seasoned a full 10 years (vintages 2000 to 2008), US$38.6bn of multifamily loans were identified as being resecuritised into an agency CMBS, accounting for 30.9% of the total securitised multifamily balance across those legacy transactions. The 2005-2007 vintages featured the greatest volumes of multifamily debt to be resecuritised into an agency transaction, representing US$8.1bn, US$9.6bn and US$8.9bn respectively. Given that those deals were primarily comprised of 10-year term balloon loans, the 2017 (US$7.8bn), 2016 (US$7.3bn) and 2015 (US$6.3bn) agency vintages received the greatest inflow of multifamily collateral from conduit transactions.

The largest loan in Trepp’s study to be resecuritised into an agency transaction was the US$878m Park La Brea Apartments note in FREMF 2015-KPLB, which is secured by a 4,245-unit apartment complex in the La Brea neighbourhood of Los Angeles. The loan has a 52.4% LTV based on the asset’s US$1.7bn appraisal value, representing a 28.8% increase from its 2006 appraisal value of US$1.3bn conducted for its prior securitisation. A 49.4% surge in net cashflow between 2006 and 2015 was a key factor in the increased appraisal, according to Trepp.

Of the 10 largest resecuritised loans in the study, the collateral for the 80 Lafayette loan - a student-housing complex in New York City – benefited from the greatest increase in value between securitisations. The underlying property was valued at US$394.3m for its securitisation via FREMF 2015-K46, a 160.4% increase from its prior securitisation appraisal of US$151.4m in 2005. NCF increased by 41.3% between the two periods, while the implied cap rate compressed by 245bp to 2.91%.

Meanwhile, the underlying asset for The Enclave loan shows the largest decline in value between securitisations. For its securitisation into FREMF 2012-K705, the underlying property was valued at US$184.3m - a 35.1% decrease from its prior appraisal value of US$284m in 2007.

Although the loan’s pro forma underwriting meant the collateral property was expected to generate US$25.3m in NCF, 2007 financials reveal that it only produced US$7.9m (31.3% of the underwritten cashflow) that year. The borrower eventually stated that it was no longer able to fund the debt service payments and the loan was resolved with an impaired payoff. The loan was underwritten in 2012 with a more conservative NCF of US$8.7m.

Trepp undertook the study using its new resecuritisation tool, which aims to provide users with a clearer picture of an asset’s overall story, including how a property may have been repositioned between cycles. McBride notes that over the last several years there has been a significant push to deepen data resources in order to better analyse underlying properties in new CMBS.

“Historically, the information on trailing financials on new loans in deal documentation was limited. What is reported can be a mix of trailing year data and lender underwriting assumptions,” he says.

He adds: “However, property values are different now to those pre-crisis, so it’s important to have a clearer picture of cashflow, NOIs and appraisals. The ability to compare then and now, as well as undertake trend analysis and analyse progression of the property over time is really valuable.”

With the 2019 lending caps for the GSEs remaining unchanged at US$35bn, agency CMBS issuance this year is expected to remain in line with 2018’s total, barring any shifts in bond pricing or demand for the underlying properties. McBride concludes: “The only possible wrinkle in the story would be if the GSEs are taken private or some new capital rules or limits are introduced. During 2015-2017, maturing loans filled the new origination engine; in 2019, we expect mostly acquisitions and refinancings to fill the origination engine.”

Corinne Smith

ABS

Private placement

Unusual tranched securitisation closed

Fintex Capital has completed a structured finance transaction within its UK real estate lending business, Fintex Confluence. The transaction involved the refinancing of a portfolio of property loans - warehoused by Fintex - with senior financing provided by Europa Capital Debt Investment (ECDI) and junior financing by Fintex, with additional monies invested by Europa and Fintex to finance a further expansion of the programme. The transaction is one of only a few privately placed tranched deals.

Robert Stafler, ceo at Fintex, explains: “It’s similar to an RMBS because every portfolio loan is executed and documented in the same way. The significance of the transaction is that it’s one of the few privately placed tranched deals and the returns are more attractive compared to comparable public deals.”

He continues: “However, the investment is not illiquid because it’s not long-term. Nevertheless, given the strong credit integrity of the portfolio, we are very comfortable with the lack of daily liquidity. Investors in public markets pay a large premium for liquidity, but often don’t find much of it when they need it most. Consequently, we are willing to surrender this perception of liquidity to capture better risk-adjusted returns.”

Brexit has been another driver behind the transaction. Stafler notes: “With so much Brexit uncertainty, it’s not easy to do deals in the UK, which is why many investors currently remain on the side-lines. However, if you would like to put capital to good use, residential is safer than commercial property, and granular portfolios are safer than concentrated ones. This is why we opt to continue growing this structured asset-backed residential debt portfolio.”

Technology plays a major role in the firm’s strategy, since managing a large portfolio requires several legal documents and valuations; the proprietary technology tools ensure that everything is in place. “This creates a culture of lending discipline, which is very important, given our manager role for both the senior and first-loss piece of the deal,” says Stafler.

The underlying portfolio consists exclusively of senior loans secured by UK residential properties. These residential assets were independently valued at between approximately £250,000 and £800,000 per property, with an average property value of approximately £500,000.

Overall, Fintex manages US$150m across its different lending strategies in the UK, US and Continental Europe, which is funded for the most part by institutional capital. In addition to its institutional partnerships, Fintex makes investments as principal and also works closely with a select group of family offices.

Prior to the completion of this transaction, Fintex operated a warehouse that allowed for the ramp-up of the portfolio and the tranching that followed. As a result of the fresh capital injection, the firm is in a position to bring more such deals in the future.

Stelios Papadopoulos

ABS

Oil opportunities

Royalty-backed future flow ABS to develop

Oil and gas companies are expected to tap the securitisation market with a new structure. The first ABS backed by oil and gas royalties could hit the market this year.

The diminished availability of traditional funding sources will lead to increased reliance on securitisations backed by oil and gas royalties to supplement traditional reserve based lending (RBL) facilities. Such securitisations will be backed by proven developed and producing (PDP) reserves.

“Master limited partnerships (MLPs) have declined in favour in the US, so ABS is able to displace existing funding sources. The traditional E&P companies, private equity companies and holders of portfolios of non-working interests would all be potential issuers for these transactions,” says Greg Kabance, md, Fitch Ratings.

The ABS would work slightly differently to standard future flow ABS, not least because they will be less dependent on the originator than other forms of future flow ABS. “The capex has already been spent to develop the wells, so there is very little exploration or developmental exposure required to monetise the flows,” says Kabance.

He continues: “ABS investors are only exposed to operational expenditure. Oil prices could dip right down into the 20s and production will still continue. PDP assets provide stable cashflows with predictable depletion rates and therefore align very nicely with longer term financing.”

Fitch has enhanced its rating framework for oil and gas royalties in anticipation of the market’s development this year. This has included volumetric production payments (VPPs), over-riding royalty interests (ORRIs) and non-operating working interests.

PDP-type production is in line with investment grade ratings, with business operations expected to continue even if an originator defaults. The first deals are expected to be able to achieve ratings of single-A, while deals issued further in the future may attain even higher ratings.

“Although these deals are less dependent on the originator than many forms of future flow ABS, there is always going to be some level of operational risk. This is a market with great scope to grow and as we see more transactions come through and a track record start to develop, it is possible there could be higher ratings in the future,” says Kabance.

There have been previous oil royalty securitisations, but they have been limited to developing countries. A series of deals from the Brazilian state of Rio de Janeiro, starting with the US$1bn Rio Oil Finance Trust Series 2014-1, is perhaps the best known, but the potential now is for deals from developed countries such as the US.

“There have been Brazilian and Argentinian deals, for example, but there is scope to expand beyond state-backed securitisations from developing countries. We are seeing more application in the US and we expect to see the first US oil and gas royalty-backed securitisations coming to the public market this year,” says Kabance.

James Linacre

Structured Finance

Secondary focus

Investors sitting on cash with new European issuance drought

European structured finance traders continue to focus on the secondary market as they wait for regulatory clarification. Nevertheless, there have still been some standout new issues and a European CMBS is rumoured to be in the pipeline.

“In European RMBS we are focussing mainly on secondary paper,” says a trader. “The transactions that appeal at the moment are those with a shorter WAL of one or two years, mainly in senior or mezz.”

The trader adds that any deals with a larger step up in coupon are trading fast. “The most interesting ones in this regard are the Hawksmoor or TPMF deals.”  

At the same time, the trader reports that the equity piece from Hawksmoor 2016-1 was recently sold to the hedge fund Davidson Kempner as a result of pricing dynamics. The Hawksmoor 2016-1 deal is backed by mortgages originated by GE and was purchased by a consortium led by Blackstone, Carval and TPG.

Notwithstanding light new issuance volumes, another trader highlights Lanark 2019-1 as a standout transaction, which displayed “very strong execution with US$3.4x and £2.7x covered. The deal was a good return for UK prime RMBS which has been in dismay after the long stream of UK non-conforming/buy-to-let transactions. The lack of any substantial new issuance in January – in terms of core paper - made for a thirsty real money community.”

Meanwhile, in CLOs the first trader says “not much has caught my attention although the Aurium CLO V priced yesterday, which was interesting – it was the only deal recently that didn’t have an anchor investor.” The second trader says they are keeping an eye on the CLO pipeline which “remains heavy” but notes that other transactions are of interest, including a rumoured Italian telecom CMBS.

While the same trader didn’t participate in the recent E-Carat 10 auto ABS primary transaction they have been keeping an eye on the sector’s secondary market. “We’ve seen a strong demand for short-dated paper across all jurisdictions from those investors typically active in auto loans. They’re willing to put the money to work, but no issuance means they’re sitting on cash.”

The trader concludes: “Regulation is killing the market - I expect to see higher fragmentation, such as on STS/non-STS, legacy, grandfathering and HQLA, and hence less liquidity. The additional sources of funding such as potential TLTRO, also dampen the willingness to issue expensive structured finance deals.”

Richard Budden

Structured Finance

SCI Start the Week – 11 February

A review of securitisation activity over the past seven days

Transaction of the week
Banco BPM has completed a €7.4bn (GBV) securitisation of secured and unsecured Italian non-performing loans dubbed Leviticus SPV (SCI 8 February). The transaction involves the transfer of the bank's servicing platform to Credito Fondiario, which is part of a broader joint-venture trend in the Italian NPL market (SCI 14 December 2018).

"The trend is driven by the desire to monetise the platforms and high regulatory scrutiny that accompany their maintenance," says David Bergman, executive director at Scope.

Rated by Scope and DBRS, the transaction comprises €1.44bn BBB/BBB class A notes, €221.5m unrated class B notes and €248.9m unrated class J notes.

The transfer of the servicing platform was the greatest rating challenge for Scope. "You get an interim period, where people move from BBPM to a joint venture controlled by Credito Fondiario - something that leads to lower recoveries, due to the lack of manpower that this period implies. However, we have taken this into account by factoring in the back-loaded recoveries."

The transaction features a number of positive drivers, including the granularity of the portfolio, with the top-10 borrowers making up only 5% of the portfolio's GBV. The credit enhancement for the senior note is 80.5%, which is unusually high compared to other NPL securitisations, given that the typical range is 70%-75%.

However, "legal proceedings haven't started for two-thirds of the loans, meaning that the recoveries will be back-loaded in time and Scope has therefore assumed a weighted average recovery time of 6.7 years, which is 31 months longer than the business plan. Furthermore, around 12% of the assets are still under construction, making them harder to value," notes Bergman.

Another issue is the lack of updated property valuations, although Scope compensates for this in its analysis by applying additional haircuts on those property valuations.

Other deal-related news

• Nord LB's owners have approved a plan to recapitalise the bank with funds from regional states and savings banks. The plan won the backing of its majority owner - the regional state of Lower Saxony, which has a 59% stake - last week, side-lining a rival offer by Cerberus and Centerbridge. The recapitalisation will further spur the bank's shipping non-performing loan disposals, although it may fall foul of EU state aid rules (SCI 6 February).  
• The RMAC Securities No. 1 Series 2006-NS1, 2006-NS2, 2006-NS3, 2006-NS4 and 2007-NS1 issuers have confirmed that they have been validly served with a Part 8 claim form by Clifden, naming them, the corporate services provider and the share trustee as defendants (SCI 28 January). The defendants consider the claim to be both procedurally defective and without merit, and are pursuing an immediate strike out and/or summary dismissal of the claim (SCI 8 February).
• Meetings for class C to E noteholders will be held on 14 February to pass extraordinary resolutions relating to the Delphine loan securitised in the DECO 2014-GNDL CMBS. Among the resolutions are the introduction of arbitration definitions and a change of maturity. For more CMBS-related news, see SCI's CMBS loan events database.

Regulatory round-up

• ESMA has agreed memoranda of understanding with the Bank of England for the recognition of central counterparties and of the central securities depository established in the UK, that would take effect should the UK leave the EU without a withdrawal agreement (SCI 5 February).

Data

Pricings
Over US$7.7bn of US ABS issuance priced last week in the busiest period so far of 2019. Meanwhile, Europe saw its inaugural public securitisations of the year via two RMBS, which cumulatively placed €1bn of bonds with investors.

Auto ABS accounted for the majority of last week's prints, comprising: US$1bn Ally Auto Receivables Trust 2019-1, US$600m Avis Budget Rental Car Funding Series 2019-1, US$373.5m DT Auto Owner Trust 2019-1, US$260m Flagship Credit Auto Trust 2019-1, US$268.44m GLS Auto Receivables Issuer Trust 2019-1, US$1.25bn Nissan Auto Receivables 2019-A Owner Trust, US$1.21bn Toyota Auto Receivables 2019-A and US$755.16m Volvo Financial Equipment Series 2019-1. Non-auto ABS issuance consisted of US$1.56bn American Express Credit Account 2019-1, US$612m GreatAmerica Leasing Receivables Funding 2019-1, US$249.13m Marlette Funding Trust 2019-1 and US$725m Stack Infrastructure Issuer series 2019-1.

A pair of floating rate CMBS also priced - US$335m CSMC 2019-SKLZ and US$336.5m Waikiki Beach Hotel Trust 2019-WBM. Finally, the European deals were €315m Fanes 2018-1 (re-offer) and US$778.74m-equivalent Lanark Master Issuer Trust 2019-1.

BWIC volume

Capital Relief Trades

Risk transfer round-up - 15 February

CRT sector developments and deal news

The first quarter of this year is expected to see reduced capital relief trade issuance, due to ESMA’s securitisation disclosure requirements, although market sources expect volumes to pick up in Q2. Among the transactions that are believed to be closing next quarter is a US corporate capital relief trade from Mitsubishi. Another deal that is set to close this year is a corporate SRT from Santander that was postponed in 4Q18.    

CLOs

Window of opportunity?

Japanese ruling may benefit US CLO market

The introduction of Japanese risk retention rules could provide a boost for US middle market CLOs, while volatility in Europe has opened up RMBS opportunities.

While most US middle market CLOs are risk retention compliant, most BSL CLOs are not, says a trader. They suggest that a risk retention ruling for Japanese investors might therefore “make them more likely to invest in US middle market CLOs.”  

The trader adds that they are generally “seeing more value in US CLOs, although recently we are seeing more opportunity in the secondary market at the moment, specifically middle market CLOs in terms of spreads on offer and the risk profile of the deals. Middle market CLOs have always offered something of a risk premium.”

Middle market CLOs will certainly see more issuance in the US this year “although whether that is a good thing, remains to be seen”, says the trader. They hint that a potential disparity in manager quality could arise, adding that “some managers are certainly more specialised than others.”

In other asset classes, UK RMBS spreads are attractive, says the trader, adding that they have been able to “take advantage of Brexit jitters”.

The trader concludes: “Markets have been widening for some time, which I don’t think is a reflection of the strength of UK RMBS deals, particularly senior notes, which have always been a strong feature of the UK securitisation market.”

Richard Budden

NPLs

Juno 2 completed

BNL closes NPL securitisation

Banca Nazionale del Lavoro has completed a €968m (GBV) non-performing loan securitisation of both senior secured and unsecured loans. Dubbed Juno 2, the transaction has a short weighted average life for collections, compared to other NPL securitisations rated by Scope.

“The vector is usually delayed compared to the business plan, but in this case the procedures are at advanced legal proceedings and therefore our assumed vector is closer to the business plan,” says Martin Hartmann, associate director at Scope. Indeed, around 35.4% of the secured loans in the portfolio are in the auction phase and 18.1% in the court distribution phase.

The courts tasked with the secured legal proceedings are mainly grouped with the faster courts - groups two and three – accounting for 50% and 25% of the portfolio respectively. Scope classifies courts over seven groups; the lower the group number, the faster the court. This results in a lower expected time for collections than for loans in higher court groups.

However, the pool’s borrower concentration is higher compared to other transactions rated by Scope. The 10 and 100 largest borrower exposures respectively account for 19% and 56.2% of gross book value, exposing the deal to potential performance volatility. Scope has applied additional haircuts to account for this.

The transaction may also include a ReoCo. “The deal may include one, although most NPL securitisations haven’t had one. Tax issues associated with the structure remain a challenge,” says David Bergman, executive director at Scope.

ReoCos are SPVs that can participate in auctions and acquire real estate assets. However, unlike standard SPVs, they are regulated, since they are consolidated on bank balance sheets and are created for the sole purpose of serving a securitisation transaction. The tax issue between the market and Italian tax authorities focuses on the capital gains from the disposal of the asset.

The Juno 2 portfolio comprises senior secured (57.7%) and unsecured (42.3%) loans (including junior secured loans), extended to companies (92.3%) and individuals (7.7%). Secured loans are backed by first-lien residential and non-residential properties (34.8% and 65.2% of property values respectively) in Italy, equally distributed in the north (32.8%), centre (38.9%) and south (28.3%).

Rated by Scope and DBRS, Juno 2 comprises €204m BBB+/BBB class A notes, €48m unrated class B notes and €12.75m unrated class J notes.

NPL securitisations soared in 2018 due to GACS, with issuance totalling €15bn since 2016 (SCI 4 February). However, the guarantee expires in March, prompting speculation as to what follows next.

Bergman notes: “If the scheme is not renewed, there will be more deals with unsecured loans rather than the mixed ones we have seen until now, because investors who want to optimise capital or funding bought large pools of unsecured loans.” Nevertheless, further extensions of the guarantee remain the most likely option (SCI 5 September 2018).

Stelios Papadopoulos

NPLs

Test case

Unsecured NPL transaction completed

Bank of Cyprus has signed an agreement for the sale of a retail unsecured non-performing loan portfolio with APS. Dubbed Project Velocity, the transaction is a test case that may further fuel future NPL transactions by the bank.

The contractual balance of the portfolio is €245m, representing the total amount owed by the borrower, including accrued charges. The actual value of NPLs that will be deducted from the bank’s balance sheet is €34m.

Portfolio sales have been crucial to the Bank of Cyprus’s strategy for resolving NPLs and project Helix was the key focus in this regard. Project Helix was a €2.7bn (GBV) real estate NPL portfolio that was sold to Apollo last year (SCI 31 August 2018).

However, the bank avoided retail in the Helix deal, given that it wanted to test the water with retail unsecured loans and this transaction is a proof of concept in this respect. Unsecured retail portfolios are typically easier to sell, given the absence of collateral valuations.

Indeed, the disposal doesn’t have a material impact for the Cypriot lender’s NPL reductions, given the small size of the deal and the fact that the bulk of the bank’s €7.6bn NPEs are secured exposures.

The portfolio comprises 9,700 heavily delinquent borrowers, including 8,800 private individuals and 900 SMEs. Project Velocity is expected to close in 2Q19.

APS has a track record of investing in unsecured NPLs in the Greek and Cypriot NPL market. The firm most recently co-invested in a €50m unsecured NPL portfolio from Piraeus Bank with the EBRD and the IFC (SCI 8 November 2018).

The latest Bank of Cyprus deal follows another unsecured transaction by Hellenic Bank that closed last year.

At over 34%, Cyprus has the second-highest NPL ratio in Europe and an estimated €13bn in unaddressed bad loans held by Cypriot banks. In recent years, Cypriot banks have tended to concentrate on improving their management of distressed assets, but last year’s launch of Project Helix has revived the market after years of relative inactivity.

Stelios Papadopoulos

CLOs

Staying selective

David Heilbrunn, senior md and head of product development, capital raising and CLOs at Churchill Asset Management, answers SCI's questions

Q: How and when did Churchill Asset Management become involved in the securitisation market?
A: Churchill was established in 2006 by The Bear Stearns Merchant Bank, the private equity affiliate of Bear Stearns. At the time, I was a senior member of the firm’s CLO business and, given my experience creating and working with successful middle market loan managers, I was instrumental in the creation of the Churchill platform. 

Bear Stearns had become attracted to the US middle market lending space several years before Churchill’s inception, as it noted that traditional lenders (i.e., regulated banks) were starting to shy away from extending credit to this important segment of the US economy. Such lenders had become more focused on maximising return on equity and middle market lending - which carried expensive regulatory capital charges and high-cost structures to maintain effective platforms - became less interesting.

In addition, the limited set of identifiable incremental business opportunities (i.e. M&A advisory, public equity and/or debt issuance, etc.) resulted in a further reduction in the appetite of regulated banks to use their balance sheets to support middle market company credit needs. The resulting shortage of bona fide credit alternatives to this important segment of the US economy created an attractive business opportunity for those willing and able to capitalise on it and served as an important catalyst to the growth of the burgeoning shadow banking sector.

Shortly after its 2006 inception, Churchill closed Churchill Financial Cayman Limited, a US$1.25bn CLO. This transaction supported 100% of Churchill’s lending activities through 2014 (the conclusion of the transaction’s reinvestment period). The CLO was a top performer, generating a 17%-plus equity IRR, with all of its rated note tranches - with the exception of its AAA/Aaa class - significantly upgraded over time.

Today, Churchill is a majority-owned affiliate of Nuveen, a TIAA company. Churchill operates as an independent affiliate and receives significant backing from its US$1trn parent in the form of capital and operational (legal, technology, compliance etc) support. The platform currently has just over US$6bn in committed capital, approximately US$2bn of which is from TIAA, fostering a unique alignment proposition for investors. 

Churchill is a best-in-class middle market senior loan manager and offers investors a variety of ways to gain access to the asset class, including separately-managed accounts, levered and unlevered commingled funds and CLOs.

Q: What are your key areas of focus today?
A: Consistent with our 13-year history, Churchill remains focused on the senior secured, private equity-backed, middle market loan space. We are thoughtful in our approach and aim to provide our private equity clientele with consistent, reliable and predictable solutions for their specific financing needs.

Churchill is a conservative investor and incorporates credit and overall management processes developed over time and tested through cycles. We directly originate our opportunities and strive to see the widest array of transactions possible.

From there, we are highly selective (on average, we invest in approximately 10% of the opportunities we evaluate) and keep our funds highly diverse. Individual positions average 1%-1.5% and we remain well-diversified in terms of geography, industry and private equity sponsor.

We have achieved an outstanding track record since our inception, having invested in over 570 loans (committing just under US$10bn in total) and experiencing a cumulative loss rate of less than 1%. Our performance record, which spanned the credit crisis of 2008-2010, demonstrates that our approach can produce attractive and stable returns across market cycles and ever-changing investing environments.

In terms of size of company, we have historically defined the US middle market space to include companies with annual EBITDA in the US$10m-US$100m range, broken down into three segments: the ‘large/upper’ middle market (companies with US$50m-US$100m of EBITDA); the ‘traditional’ middle market (companies with US$10m-US$50m of EBITDA); and the ‘lower’ middle market (companies with less than US$10m of EBITDA).

Today Churchill is squarely focused on the ‘traditional’ middle market segment, given appropriate leverage levels, conservative structures and manageable and like-minded lender groups. For example, during 4Q18, Churchill originated over US$1bn in new commitments across 36 transactions (16 new LBOs and 20 add-on opportunities to existing portfolio companies). Average EBITDA of our new borrowers was just under US$30m, all loans had financial covenants and exhibited moderate leverage (3.8x/4.8x senior/total respectively).

In general, we are attracted to borrowers with proven track records through cycles, experienced and well-aligned management teams and private equity owners who we are familiar with, have worked with in the past and have incremental capital available, should the need arise. 

Given current market dynamics, we are somewhat sceptical of opportunities in the ‘large/upper’ end of the middle market, which we believe currently offers riskier   transactions with high levels of leverage, aggressive structures (often with no covenants) and unfamiliar and untested lender groups. In addition, historically, Churchill has shied away from the ‘lower’ middle market, given the challenges that these companies can face in a cyclical downturn.

Q: How do you differentiate yourself from your competitors?
A: Churchill is a well-established, long-standing member of the “middle market club”. Over our 13-year history, we have been a consistent partner to our top private equity clients, becoming somewhat of a household name, all while achieving one of the top track records in the market.

With detailed credit processes developed over a long timeframe (which spanned a very challenging period) and a senior team which has been together since the inception of the company, we are a reliable lender to the private equity community. In particular, Churchill’s platform compares favourably to our competitors in several ways.

Churchill’s long-standing presence in the middle market has contributed to its reputation as one of the most active and reliable middle market lenders.  The firm is well-known and respected among its private equity clientele, a relationship which is further enhanced by the fact that its ultimate parent’s (TIAA) is one of the largest investors in private equity funds in the US.

The senior members/founders of Churchill are still together today. In addition to building a strong culture anchored in fundamental credit analysis, this consistency is highly valued by our clients and investors alike.

With over US$6bn in committed capital (spread across numerous vehicles), Churchill can commit significant amounts on a per loan basis (up to US$200m in select circumstances). Our processes enable us to provide early feedback to our private equity clients, which - along with certainty of execution (with a lender who they have likely worked with before, including through past cycles) - is highly valued.

Finally, Churchill has unique alignment with and benefits from the resources of a US$1trn parent. TIAA retains approximately a third of all loan exposure originated by the Churchill team on the same basis as third-party investors. This reality creates a unique and strong alignment of interests proposition for third-party investors.

Q: What is your strategy going forward?
A: Today, Churchill has over US$6bn of committed capital, roughly a third of which comes from its ultimate parent TIAA (which retains approximately a third of each loan Churchill extends, creating a unique alignment proposition for investors), with the balance coming from third-party investors. The size and scale of Churchill’s platform enables it to commit significant amounts per transaction to its private equity clientele.

Given the diversity of its product offerings (separately-managed accounts, levered and unlevered commingled funds and CLOs), Churchill can commit these amounts while remaining well-diversified in each of its underlining funds. Scale while remaining well-diversified at the fund level is central to Churchill’s strategy today and going forward.

CLOs are an important part of Churchill’s product array, as they represent an efficient alternative for raising long-term, locked-up capital, especially for firms who have a demonstrated history of managing these transactions and the litany of associated portfolio management requirements. Churchill has consistently managed significant portions of its business within the constraints of CLO/securitisation structures and such requirements have become part of the overall credit management approach employed by the firm. As such, Churchill remains active in the CLO space with two closed transactions – TIAA Churchill Middle Market CLOs I and II (CLO I was successfully reset in October of 2018) – and three more in various stages of ramp (two of which are expected to close in 2019 and the third in 2020).

Churchill’s ultimate parent (TIAA) has the appetite for the equity and lower rated tranches issued by these CLOs. As such, Churchill’s CLO transactions comply with US and European risk retention requirements.

Q: What major developments do you expect from the market in the future?
A: As we head into the later part of the credit cycle, aggressively structured middle market CLOs are likely to experience challenges. For example, if and when overall market conditions start to deteriorate, the rating agencies are likely to become more conservative as it relates to the rating estimates they provide on the loans included in middle market CLOs, often downgrading their estimates on solid credits below B3/B-.

When coupled with increasing default rates, excess exposure to assets with rating estimates below B3/B- will erode critical overcollateralisation cushion levels, thereby increasing the probability of an early capital structure amortisation event. Therefore, it is very important, especially later in the credit cycle, that middle market CLOs are structured with the appropriate amount of portfolio management flexibility and avoid setting unnecessarily tight covenant levels to maximise leverage and projected equity returns.

Middle market CLOs still provide attractive return profiles, but recent widening in the associated liability spreads has put pressure on the overall arbitrage and resulting equity returns. Asset spreads have normalised, so we hope to see the situation improve over the coming months, as CLO debt investors continue to look to put money to work in this important segment of the market.

Structured Finance

Insurance firm expansion

Sector hires and company developments

Insurance firm expansion

Nassau Re is expanding into additional specialty finance asset classes as it grows assets under management in a three-pronged move. First, the firm has established Nassau Private Credit (NPC), which will invest directly in CLO equity and related investments for third-party institutional investors. Second, under its Nassau CorAmerica brand, it will expand its existing real estate commercial whole loan capabilities to include floating rate debt investments. Third, the firm is expanding its alternative investments practice to grow its private equity investing and co-investment platforms. As part of the expansion, Bruce Brittain and Russell Pemberton are joining the firm as mds and lead portfolio managers for NPC. Brittain was most recently a co-founder and principal of Morningside Credit Partners, while Pemberton was most recently head of CLO syndicate and origination at RBC Capital Markets.

Law firm makes CLO hires

Howard Goldwasser and Skanthan Vivekananda have joined Orrick as partners in its structured finance group from Arnold & Porter, based in New York and Los Angeles respectively. The pair have been working together as a team for the last eight years, including at K&L Gates from 2011 to 2016, and have particular expertise in the post-crisis CLO market. Goldwasser was formerly a partner at Orrick from 1999 to 2006.

Structured Finance

Bank expands credit derivatives business

Company hires and sector developments

Credit trading expansion

HSBC has hired Asgar Rahemtulla as a director in credit trading. In his new role, Asgar will be responsible for trading European iTraxx index products. He joins HSBC from Bluecrest where he was a Partner and worked as a portfolio manager. Prior to this he spent eight years at Goldman Sachs in a variety of roles including leading iTraxx index trading. The move comes at a time that HSBC is building out its credit derivatives capabilities and he will be based in London, reporting to James Deighton, md, credit trading.

Leopalace defects

Leopalace 21 Corp has disclosed that additional construction defects have been discovered in apartment buildings that it built (SCI 29 June 2018), which Moody’s says are credit negative for the four ABS transactions it rates that are backed by apartment loans on properties built and managed by the firm. The agency warns that the defects could lead to lower rents or higher vacancy rates in the affected buildings. Additional defects were identified in 1,324 apartments built between 1996 and 2001, with residents in 641 apartments asked to promptly vacate their properties because the defects relate to fire resistance requirements. Moody’s notes that the ABS are unlikely to include a material number of loans on apartments affected by the latest round of defects, based on the years the buildings were constructed, but the reputational damage will likely make it harder to attract tenants to the properties.

SME facility secured

Praetura Asset Finance (PAF) Group has closed a £75m securitisation facility with Natwest Markets. The rated facility will allow PAF Group to expand its origination capacity, enabling growth in its loan book to provide up to £200m to SMEs across the UK.

Structured Finance

Italian auto firms fined

Company hires and sector developments

CLO hire

Geoffrey Horton has joined Barclays as vp, CLO and loan strategist in London. He was previously a CLO and commercial ABS research associate at Wells Fargo in the US.

Italian auto firms fined

The Italian Competition and Markets Authority (Autorità Garante delle Concorrenza e del Mercato or the ICA) recently fined nine captive auto finance companies a total of over €678m for distorting the Italian auto finance market. DBRS believes the recent actions by the ICA should not materially affect Italian auto ABS transactions. However, DBRS notes that there could be an increase in prepayments as borrowers look to terminate early with improved competition. Nevertheless, the effects of prepayments on individual transactions may differ depending on specific structural features. DBRS believes the ICA’s auto fines will have a neutral credit impact on existing Italian structured finance transactions but it may create more competition in the market. The nine companies implicated are as follows: Banque PSA Finance, Banca PSA Italia (the captive finance companies of PSA Peugeot Citroën), BMW Bank GmbH (the finance arm of BMW AG), FCA Bank (a joint venture of Fiat Chrysler Automobiles N.V. and Credit Agricole Consumer Finance ), FCE Bank Plc (Ford Motor Company), Opel Finance (formerly General Motors Financial Italia), RCI Banque S.A. (Renault), Toyota Financial Services (Toyota Motor Corporation) and Volkswagen Bank (Volkswagen AG).